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A proposal for a multilateral border carbon adjustment scheme that is consistent with international trade law

by Brian Chang,

June 2017

As the world considers how to respond to the Trump Administration’s decision to withdraw from the Paris Climate Agreement, it may wish to consider the adoption of a border carbon adjustment scheme that is compatible with international trade law as one, but not the only, possible policy response. The EU and China have already indicated that they will work together to strengthen the Paris Agreement, and have been quietly forming a group of like-minded states whom they will work with in coordinating a response, although they may encounter difficulty working within a near-universal framework based on consensus (such as the UNFCCC framework, which gives every country a veto).

In particular, world policymakers will wish to consider adopting policy responses that disincentivise further withdrawals from the Paris Agreement causing a “domino effect,” and that incentivise voluntary participation by US states, cities and industries. World policymakers will also wish to incentivise the ratcheting up of commitments both to the reduction of carbon emissions and to international climate funding in order to make up the shortfalls caused by US withdrawal. World policymakers will also have to be aware about the possibility that US may attempt to play a spoiler role in UN negotiations, and be careful to communicate their intention and plans well in order not to provoke the Trump Administration into throwing a tantrum. These weighty considerations, which draw on the work of Luke Kemp, the academic who arguably deserves an award for the most prescient article title of the year, need to be carefully considered, and it may be that a border carbon adjustment is not the best, nor the only policy response that should be adopted.

The essential thesis of this blog post, which summarises a longer paper, is that international trade law will permit border carbon adjustments (BCAs) on products from the US, if the Trump administration withdraws from the Paris Agreement, so long as these schemes are well-designed to avoid the World Trade Organization (WTO) prohibitions on arbitrary or unjustified discrimination and on disguised protectionism, as interpreted by the WTO’s Appellate Body in its US–Shrimp report and US–Shrimp 21.5 decision. To illustrate this thesis, this post proposes a multilateral border carbon adjustment scheme (MBCA) that other countries could agree to impose on the US, that would meet the objectives stated above of disincentivising further withdrawals, incentivising voluntary participation by American actors, continuing the ratcheting up of carbon reduction commitments, and making up the shortfall in international climate funding.

The proposed multilateral border carbon adjustment scheme

Form: A multilateral or plurilateral agreement within the framework of the Paris Agreement

Article 6 of the Paris Agreement recognises that some parties may choose to pursue voluntary cooperation in the implementation of their carbon emissions targets to allow for higher ambition in their mitigation and adaptation actions and to promote sustainable development and environmental integrity (Article 6.1), and mandates the creation of a mechanism to contribute to GHG emissions mitigation and support sustainable development (Article 6.4). This mechanism is not stated to be the exclusive means through which parties may pursue voluntary cooperation. The proposed multilateral border carbon adjustment scheme could therefore be agreed under the mechanism created under Article 6.4, or as a plurilateral agreement under Article 6.1 between countries that wish to take collective efforts to tackle climate change. While it would be preferable for the MBCA to be adopted by the Article 6.4 mechanism created by the Paris Agreement, it is arguably possible for the MBCA to be adopted under Article 6.1 of the Paris Agreement should non-state parties pressure states parties to block consensus within the Article 6.4 mechanism.

Design and structure

The proposed MBCA would distinguish between states parties to the Paris Agreement and non-states parties. In its simplest form, such a scheme could (a) exempt states parties from BCA, as they have committed to undertake efforts to reduce GHG emissions within the UNFCCC framework (i.e. by submitting carbon emissions targets (Intended National Determined Contributions or INDCs) within the framework of the Paris Agreement), while (b) permitting participating countries to impose BCA on products from non-states parties that have not committed to undertake efforts to reduce GHG emissions, subject to the principle of common but differentiated responsibilities and respective capabilities; and (c) create a rule enabling sub-national entities or foreign companies to apply for exemption from the MBCA if they participate in equivalent carbon pricing initiatives.

While ideally participating countries would agree on a common BCA measure, given the diversity in practice of carbon pricing initiatives and the necessity under international trade law of not imposing measures that unduly disadvantage imports against domestic production (e.g. by imposing a carbon tax of US$20/ton of CO2 on imports when domestic carbon trading permits cost US$10/ton of CO2), participating countries may find it difficult to develop a common BCA measure (which is not a “lowest common denominator”), but should (d) commit to imposing BCAs that are designed to ensure equivalent carbon pricing on their domestic production and imports from non-participating countries. This would have the effect of requiring exporters from non-states parties to either comply with the national carbon pricing regimes of all participating countries that they export to, imposing a regulatory burden on them; or to voluntarily participate in equivalent carbon pricing schemes.

A further design option that may not be strictly necessary under international trade law but would strengthen the MBCA, is for participating countries to transfer most if not all financial proceeds to a climate change mitigation or adaptation fund for affected countries. This would strengthen the evidence of the non-economically protectionist intention and design of the MBCA before the WTO Dispute Settlement Body (DSB), make up part of the shortfall in international climate funding, and increase international support for the MBCA.

Justifications

The MBCA should be justified on the basis of non-economic environmental reasons (rather than economic competitiveness reasons, in order to be international trade law compliant), such as internalising the social cost of carbon, reducing carbon leakage, enabling wider and deeper emissions reductions within the regulating countries, incentivising others to join the Paris Agreement, and ensuring that domestic consumers are not incentivised to buy products from countries that make no attempt to internalise the cost of carbon, and do not share the regulating countries’ commitment to reducing carbon emissions. These justifications and the structure of the MBCA demonstrate that the primary motivation behind the MBCA would not be concerns to protect the economic competitiveness of domestic industries (since countries that are party to the Paris Agreement which are doing less to internalise the cost of carbon would not face similar BCA), but to exclude non-states parties to the Paris Agreement from a benefit exclusive to states parties – exemption from BCAs.

Consistency of proposed multilateral border carbon adjustment with international trade law

Because the proposed MBCA treats imports from countries which have submitted INDCs differently from imports from countries which have not, it would appear to violate the most-favored-nation obligation under international trade law (Article I of the General Agreement on Tariffs and Trade or GATT for short). However, the violation can be justified under the general exceptions regime to the GATT (Article XX) as being necessary for the protection of human, animal, or plant life or health, or relating to the conservation of exhaustible natural resources.

Jurisdiction: A “sufficient nexus”

Some might argue that countries should not be allowed to regulate activity (in this case, carbon emissions) that occur outside their territory or jurisdiction, essentially requiring their import sources to adopt similar conservation policies. This argument parallels the reasoning of the first Tuna/Dolphin Panel in the US–Tuna disputes, which prioritised the effectiveness of international trade rules over the conservation object, and attempted to limit the US’s right to regulate to matters within its territory. This Panel report was not adopted by the DSB, meaning that it has little precedential weight (as the US rejected this view). The better view, which was set out by the Appellate Body (AB) in its US–Shrimp report, is that countries may regulate activities outside their territory or jurisdiction and may even do so unilaterally, provided that there is a “sufficient nexus” between the territory or jurisdiction of the regulating country and the object of protection. Although the AB in US–Shrimp deliberately left open the question of whether there is a jurisdictional limitation on the reach of conservation policies justified by paragraph (g), there is no need for this question to be addressed when considering BCAs, as the DSB is likely to accept that there is a “sufficient nexus” between measures taken to protect the planet’s climate and the territory of the regulating countries (which will be affected by climate change).

Non-arbitrary and justified discrimination

The non-discrimination requirement in the chapeau of Article XX requires that the MBCA takes into account the local conditions in foreign countries, since discrimination occurs (a) when countries in which the same conditions prevail are treated differently; and (b) when the measure “does not allow for an inquiry into the appropriateness of the regulatory program for the conditions prevailing in those exporting countries.” This principle aligns well with the principle of “common but differentiated responsibilities and respective capabilities” (CBDRRC), which calls for developed countries to take the lead in tackling climate change, while recognising that developing countries may bear little historic responsibility for existing GHGs in the atmosphere and a lower ability to address carbon emissions while pursuing economic development (as manifested in Article 4 of the Paris Agreement). Hence, BCAs should take into account the CBDRRC principle, in order to avoid arbitrary or unjustified discrimination.

To avoid arbitrary or unjustified discrimination, AB jurisprudence in the US–Shrimp 21.5 report requires that the MBCA should not seek to rigidly impose one policy or measure on all countries, but allow for “sufficient flexibility in the application of the measure” for other countries to adopt programs “comparable in effectiveness.” While the MBCA cannot require that all other countries “adopt essentially the same policy” and refuse to take into account the “other specific policies and measure that an exporting country may have adopted for the protection and conservation of [the planet’s climate],” the AB has stressed (in its US–Shrimp report) that “countries are free to adopt their own policies aimed at protecting the environment” and that importing countries may require exporting countries to maintain specific environmental policies and measures that are comparable in effectiveness in dealing with the policy concern it is invoking.

To strike the balance between recognising the principles of non-discrimination and CBDRRC, giving exporting countries sufficient flexibility to adopt their own measures, while preserving importing countries’ right to regulate to protect the planet’s climate, the proposed MBCA would impose BCAs only on countries that have not submitted INDCs under the Paris Agreement, while allowing developing countries that are unable to submit INDCs to apply for exemption from BCAs. This proposal recognises INDCs as each country’s attempt to pursue measures of “comparable effectiveness” in pursuit of the common object of protecting the planet’s climate, taking into account their different circumstances, while preserving importers’ right to impose regulation on exports from countries that do not adopt any measures to protect the planet’s climate. While the imposition of BCAs only on countries that do not adopt any measures to protect the planet’s climate is discriminatory, this is arguably non-arbitrary and justified, and the WTO DSB is likely to find the proposed MBCA to be consistent with its jurisprudence to date, provided that it finds on the facts that the proposed MBCA is designed and intended to protect the environment and not to protect the economic competitiveness of domestic industries, and the proposed MBCA meets its other standards.

The requirement for negotiations

Before the proposed MBCA is imposed, “serious, across-the-board negotiations with the objective of concluding bilateral or multilateral agreements” that address climate change need to be undertaken, although those negotiations need not lead to the conclusion of agreements. The AB found the revised unilateral measures undertaken by the US examined in its US–Shrimp 21.5 decision to be justified under the chapeau, as long as the “ongoing, serious good faith efforts to reach a multilateral agreement continue.” Since the Paris Agreement is a multilateral agreement that represent the culmination of years of efforts to reach consensus on measures to address climate change, it arguably suffices for the imposition of the proposed MBCA on countries that refuse to submit INDCs or that leave the Paris Agreement, as long as the parties to the Paris Agreement make ongoing, serious good faith efforts to negotiate with these countries.

While the above design considerations should be sufficient for the proposed MBCA to pass muster under Article XX, additional design considerations will improve the chances that the WTO DSB will find that the measure is motivated by concerns to protect the planet’s climate, and not economic protectionist sentiment. Firstly, the MBCA should allow industries and sub-national entities within non-Paris Agreement countries to avoid BCAs by participating in equivalent carbon pricing schemes. Secondly, BCAs should only be imposed on imported goods, and there should not be attempts to subsidise or provide rebates to exports to countries with no carbon prices, as the intent and likely effect of this is to bolster exports, not to reduce emissions.

Finally, if the entire proceeds or a substantial part of the border carbon adjustment are transferred to a climate change mitigation or adaptation fund that provides assistance to affected countries, this would help the MBCA pass Article XX scrutiny, as well as improve its political acceptability to many of the developing countries opposed to BCAs.

Recommendations for the design and use of BCAs based on international trade law

To conclude, international trade law provides a number of rules and disciplines that will govern the design and use of BCAs, which make it difficult but not impossible to enact BCAs. These rules may be distilled into seven recommendations, which all BCA schemes should comply with, in order to maximise their compatibility with Article XX of the GATT:

Be justified on the basis of environmental protection rather than competitiveness concerns;

Be adopted within a multilateral framework (such as Article 6 of the Paris Agreement);

Be adopted alongside ongoing, serious good faith attempts at negotiating a solution with countries that the BCA would apply to (though such negotiations need not be successful);

Meet the WTO standards for basic fairness and due process, such as publication and the provision of a mechanisms for appeals;

Take into account the principle of “common but differentiated responsibilities and respective capabilities” in order not to constitute an arbitrary restriction on developing countries with little historic responsibility for existing GHGs in the atmosphere and a lower ability to address carbon emissions while pursuing economic development; and

While the above recommendations should suffice to ensure that the WTO DSB finds the BCA to be consistent with international trade law, another recommendation that may greatly strengthen the political feasibility of a BCA is (8) transferring the proceeds of the BCA to a climate change mitigation or adaptation fund for affected countries.

Brian Chang is a Thomas Buergenthal scholar at the George Washington University.

This article features an updated version of a blog post that first appeared on 22 May 2017 on EJIL: Talk!